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II-VI and Finisar – A Merger of Equals

Nov. 9, 2018

LightCounting explores II-VI’s acquisition of Finisar in a new Research Note

It is not fun to be the second company in a crowded market; the urge to be first can be overwhelming. Finisar and II-VI found a solution by joining forces. II-VI Incorporated announced an agreement to acquire optical transceiver market leader Finisar on November 9, 2018, and LightCounting has published a Research Note exploring the ramifications of the deal for II-VI and the optical components industry. Our key findings:

More deals may come, given the high premiums paid for Oclaro and Finisar

The deal values Finisar shares at a 37% premium over the market close on November 8, and has a value of $3.2 billion. The acquisition will be financed by a combination of $1 billion in cash, $2.0 billion in new debt, and $1.4 billion in new stock, and is subject to a variety of regulatory and antitrust approvals. The combined company will have annual revenues of almost $2.5 billion, 24,000 employees, and 70 locations. II-VI posted GAAP net profit in the last four quarters, whereas Finisar did not. The Finisar acquisition is subject to regulatory approvals in the U.S., China, and possibly elsewhere, so the deal is unlikely to close before mid-year 2019.

II-VI acquired 15 companies over last 15 years, but Finisar is by far the largest. It puts the new company within reach of the top spot among photonics and compound semiconductor companies, as illustrated below.

Figure 1: Comparison of Photonics and Semiconductor companies

Source: Webcast Presentation of II-VI Incorporated

Finisar’s optical components products and technologies complement II-VI’s very well with little overlap, as shown in Table 1. Both Finisar and II-VI have 6-inch Gallium Arsenide wafer fabs, so some of the cost synergies may come from this area.

Table 1: Finisar and II-VI product and technology synergies

Source: II-VI and Finisar

II-VI and Finisar have both invested heavily in catching up with Lumentum in the new market for VCSEL arrays for 3D depth sensing used for facial recognition in smartphones. Finisar invested close to $100 million in a new 6” wafer VCSEL production fab and planned to have the new facility qualified by Apple by the end of 2018. With its recent acquisitions of EpiWorks and Anadigics, and now Finisar, II-VI will have the ability to produce VCSELs completely in-house, and in the high volumes required for the consumer market. More information about the market for VCSEL arrays for 3D sensors in smartphones is available in LightCounting’s report: VCSEL Arrays in 3D Depth Sensing in Smartphones.

II-VI does not make or sell optical transceivers, so the acquisition of Finisar adds that $5.9 billion opportunity to II-VI’s total addressable market. In addition, Finisar’s VCSEL array capabilities greatly increase II-VI’s competitiveness in the 3D sensor array market, which LightCounting recently valued at $600 million for 2018, growing to $1.8 billion by 2023. So in total, the addition of Finisar’s products, technologies, and capabilities opens up some $6-7 billion in new market opportunities for II-VI.

The 37% price premium being paid by II-VI over Finisar’s market share price is certainly attractive. Lumentum is paying 27% above the prior day market price for Oclaro. Lumentum’s stock price rose into the low $70’s shortly after the Oclaro acquisition was announced, and although it has since fallen to the $55-$60 range, it is still higher than the average in the quarter before the deal was announced. With these attractive multiples other components companies must be considering if a merger/acquisition makes sense for them.

LightCounting releases a new report addressing illumination in smartphones and automotive lidarIn 2019, the market for VCSEL (vertical cavity surface-emitting laser) illumination in smartphones will exceed $1.0 billion – now nearly triple the size of the market for communications VCSELs. That’s quite remarkable for a market that didn’t exist three years ago.3D sensing in smartphones felt like an overnight sensation, but the technology foundations were laid down years ago with Microsoft’s Kinect – a motion-sensing peripheral for gamers released in 2010 but discontinued in 2017 after lackluster sales. Lumentum supplied lasers to the Kinect almost a decade before the iPhone opportunity emerged; the company was ready to profit from the iPhone X opportunity when Apple decided to launch 3D sensing for facial recognition in September 2017.

Figure: 3D depth-sensing meets the Gartner Hype Cycle

Source: Gartner with edits by LightCounting

If all technologies follow the Gartner Hype Cycle, shown in the Figure above, then 3D sensing in smartphones is now moving up the slope of enlightenment. Android brands raced to add 3D sensing to their flagship phones in 2018 – the Xiaomi Mi8 Explorer and Oppo Find X phones were first – although these only sold in single digit million quantities. Huawei also brought out new phones with 3D sensing, but the ongoing U.S. export ban on the Chinese company must be hurting the company’s traction outside China. Apple continues to dominate the market as all new iPhones released by Apple since 2017 have included 3D sensing on the front of the phone. Apple is expected to introduce 3D sensing for ‘world-facing’ applications in 2020, which adds another laser chip to every phone.

Last year illumination for lidars were not included in our market forecast since LightCounting considered it unlikely that lidar would penetrate the consumer market to any great extent over the forecast period. All indicators now point to a market for lidar illumination ramping up in 2022 and beyond. Optical components firms are now shipping prototypes and samples of VCSELs, edge emitters and coherent lasers to customers developing next-generation lidar systems – many of them building on their expertise in illumination for optical communications and smartphones.

As was the case with smartphones, the foundations for lidar technology were laid down much earlier – in this case with the DARPA Challenge 2007, where the winning vehicle used a 64-laser lidar system from Velodyne Acoustics (now Velodyne Lidar). Lidar is considered by the majority of the industry to be an essential part of the sensor suite required for autonomous driving, helping the vehicle to navigate through the environment and detect obstacles in its path. The first commercial deployments have begun. In Germany, lidar on the Audi A8 enables the car to drive itself for limited periods under specific conditions. In Phoenix, Arizona, you can hail a ride in a Waymo robotaxi.

Investor enthusiasm for lidar is undeniable with nearly half a billion dollars invested in lidar start-ups in 2019 according to our analysis of publicly available investment data. Notable deals include $60 million for U.S. company Ouster in March, Israel’s Innoviz Technologies Series C round of $132 million in the same month, and $100 million for U.S.-based Luminar Technologies in July. Interestingly, these examples illustrate the variety of lidar approaches: each company is building a different type of lidar based on a different wavelength: 850nm for Ouster, 905nm for Innoviz and 1550nm in the case of Luminar. There’s an open technology battle and they can’t all be winners.

The automotive lidar market seems to be close to the peak of ‘inflated expectations’. It’s easy to understand why. The automotive industry is enormous, with nearly 100 million vehicles (including trucks) produced annually. Players like Baidu, GM Cruise and Waymo are backed by deep corporate pockets, and new entrants like Aurora and Pony.ai are attracting hundreds of millions in investment. Intel’s $15.3 billion purchase of Mobileye in 2017 was also directed at autonomous driving. Sensor company AMS is in a $4.8 billion battle to acquire German semiconductor lighting firm Osram with its eye firmly on lidar.

However, signs indicate that the descent into the trough of disillusionment could have already begun. Waymo has yet to roll out its robotaxi services more widely – and this summer admitted that its vehicles needed more testing in the rain. GM Cruise has delayed launch of commercial services for self-driving cars beyond 2019 and is reluctant to commit to a new timescale, with its CEO Dan Ammann observing that safety is paramount; automotive is not an industry where you can “move fast and break things” he said. A casualty of the slow pace was optical phased array lidar developer Oryx Vision, which closed its doors in August and started to hand money back to investors.

While lidar is being deployed commercially today, prices are not conducive to mass production, and there are open questions around regulation, safety, ethics and consumer acceptance. Do local laws prohibit self-driving cars? Will they really be safer than humans? Who is responsible for a crash? LightCounting remains skeptical about the pace of adoption of autonomous vehicles, but will be watching the market closely and with optimism.